Inflation or Deflation, That is the Question

by cactus

Inflation or Deflation, That is the Question

These days some smart people are expecting inflation, other smart people are expecting deflation, and there’s another big batch of smart people who are either expecting both or don’t know. I figured – why should smart people have all the fun?

So I came up with a working hypothesis that the evaporation of wealth created a hole in the public’s collective balance sheet which the Fed is trying to fill with money. While the hole doesn’t have to be completely filled for there to be inflation, I suspect while the hole is mostly empty pumping money in won’t create inflation. After all, for years following the dot com bomb, the Fed kept the money supply nice and loose and there was no inflation. (And yes, I’m sidestepping what constitutes a mostly empty hole and at what point it becomes filled enough for inflation to be a worry.)

I got net worth for households and nonprofits (sorry, but the Fed groups nonprofits in there and I can’t find this series without nonprofits) and m2 from the fed, both quarterly. I annualized quarterly inflation, then adjusted both series (net worth and M2) and then divided by population. I then graphed ’em both. (Note – normally I would use M1 as opposed to M2 because the Fed has more control over M1. However, in this instance, it seems that some of the actions we’ve seen the Fed plus the gubmint take are intended to loosen up components of M2 that are not encompassed in M1, so I’m going with M2 here.)

The hole in the public’s collective balance sheet appears to be quite a bit bigger than the pile of money the Fed has shoveled into it, or rather, into the big players on Wall Street. (Note the big difference in the scale of the two axes!!) Thus, for the time being at least, I think we’re closer to deflation (in general) than inflation (in general).

I realize this isn’t the usual way to think about inflation, and I’m not sure its right. Any thoughts?

Data
households and nonprofit organizations net worth (market value) asset
CPI, M1, M2 and Population
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by cactus

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